After a turbulent 2018, don’t expect a smoother ride for the stock market in 2019. But unless you are especially cautious, don’t let the stomach-wrenching gyrations scare you away—at least not before 2020. So says renowned economist and Bottom Line Personal regular contributor Allen Sinai. Reason: Despite rising interest rates, trade wars and continued political combat, the economy will continue to benefit from federal tax cuts, robust corporate earnings and muted although elevated inflation. That means a near-zero chance of recession before 2020, Sinai says, adding that without a recession on the horizon or unreasonably high interest rates, the longest bull market in history can continue through 2019 and even into 2020. Here’s what Sinai sees ahead…
BULL MARKET FAR FROM DEAD
Extreme volatility is likely to continue in 2019 as investors attempt to reconcile strikingly positive economic news and healthy corporate profits with a host of red flags. This may feel like dangerous, uncharted territory—but it’s characteristic of the late phase of an economic expansion, where panicky investors often make the mistake of jumping out too early and missing decent stock market gains. In fact, I expect the Dow Jones Industrial Average to return 8% for 2019, including dividends.
Reasons behind those expected gains: The US economy is getting stronger. The total amount of stimulus in 2019 from tax cuts and federal government spending will more than double from the level in 2018. Capital spending will jump as companies take advantage of the vibrant US economy and put money from the biggest corporate tax cuts in history to work. And consumers are benefiting from rising wages and tax cuts.
Despite this renewed vigor, I expect inflation to remain under control. Prices for consumers and the cost of labor for companies are being contained by transformational technologies—think smartphones and Amazon.com—that allow us to save time, increase worker productivity and instantly find the lowest prices on whatever we want to buy.
Thanks to all these positives, I believe the markets can overcome various red flags, which include…
Rising interest rates: One big fear is that the Federal Reserve may raise short-term interest rates too aggressively. That would increase the cost of borrowing for consumers and companies and inhibit economic growth. In reality, however, moderate inflation means that the Fed is likely to raise rates only moderately.
Congressional combat: Democrats, now in charge of the House of Representatives, are so profoundly opposed to most of President Donald Trump’s agenda that they are likely to try to thwart him at nearly every turn. But that doesn’t change the investment outlook. Tax cuts and increased government spending will remain firmly in place. Just having the midterm elections behind us is a major plus for stocks. Since the Dow was created, its stocks have produced, on average, an annualized return of just 1.4% in the six months before midterm elections but a 21.8% annualized return in the six months afterward. And I believe that rising federal budget deficits—a serious, longer-term problem—won’t hurt the economy or stock market in 2019, in part because increased economic growth helps lift tax revenue.
Global trade wars: Trump’s tariffs have the potential to wreak havoc on some American companies. But the US has already struck a trade deal with Canada and Mexico that allows greater US exports to our two largest and most important trade partners. I expect that the US will negotiate agreements with our European allies. And the US will probably avoid an all-out trade war with China. (For the worst-case scenario, see the box below.)
My outlook for economic expansion: In June, the current expansion will break the 10-year record set in the 1990s and become the longest in US history. It should continue through 2020, possibly even into 2021. However, investors will need to start taking defensive measures such as reducing stock allocations because bear markets typically emerge four to 12 months before recessions do.
KEY US ECONOMIC MEASURES
Here’s what to expect for 2019…
Gross Domestic Product. GDP likely will gain 3.1% (after adjusting for inflation) for all of 2018 and 3.3% in 2019. These gains will be driven not just by strong consumer demand, up 3% in 2019, but also by an increase of more than 10% in capital spending.
Inflation. The Consumer Price Index (CPI) likely will rise 2.4% for 2019, similar to the 2.5% over the past year through October 2018. The Fed’s interest rate increases will keep inflation from getting worse than that in 2019.
Unemployment. The US should end 2019 with an unemployment rate of 3.1%, the lowest since the Korean War, compared with 3.7% in October 2018.
OUTLOOK FOR STOCKS
Including dividends, the Dow likely will return 8% in 2019…and the Standard & Poor’s 500 stock index, 9%. Stock valuations from a historical perspective are not high overall, especially after the market’s sharp pullback in October. Earnings of S&P 500 companies likely will rise 11%, on average, less than the earnings growth in 2018 but still hefty.
Best stock sectors for 2019…
Health care. This is the US economy’s fastest-growing area in terms of consumer spending and new jobs.
Consumer staples. These companies produce essential products such as food, beverages and basic household items. Their reliable cash flow makes their stocks less volatile than the overall market and will attract nervous investors.
Technology. I am still positive on tech despite high valuations. Areas such as cloud computing and e-commerce will especially benefit from rising consumer and business spending.
Areas of the market to avoid…
Housing-related stocks. I expect 30-year fixed mortgage rates to hit 5.5% by the end of 2019, up from about 5% in early November 2018 and as low as 3.8% in 2017. The higher rates and falling sales of new single-family houses will weigh not only on the stocks of home builders and building-material companies but also on home-goods manufacturers and retailers.
OUTLOOK FOR BONDS
I expect the Fed to increase the federal funds interest rate to a range of 2.75% to 3% by the end of 2019, compared with 2% to 2.25% as of November 2018.
Bonds already are in a bear market. In general, they should be avoided in 2019 unless you plan to hold them to maturity. The bond bear market will only deepen as interest rates rise. I expect the broad bond market’s total returns (capital appreciation plus yield) to be negative for 2019. I’m forecasting that the yield on 10-year Treasuries, which was 3.22% in early November 2018, will top 3.75% by the end of 2019.
Conservative investors and those who are nervous about market volatility should consider raising cash or turning to very short-term fixed-income investments, especially now that there are attractive yields on savings. Recently, a three-month US Treasury bill yielded 2.4%, its highest yield since 2008, and online money-market accounts have topped 2%.
THE BIGGEST TREAT TO STOCKS
Of all the challenges facing the stock market in 2019, I’m most concerned about the bitter trade dispute between the US and China. My economic and stock market projections are based on the two superpowers reaching a compromise or at least maintaining current tariff levels. However, existing US tariffs (10% on about $200 billion worth of goods from China ranging from fish and luggage to electronics and furniture) are scheduled to rise to 25% on January 1. That could spiral into a full-blown trade war. Tariffs can add to inflation, causing the Fed to increase interest rates more sharply, hurting consumer spending and stock prices.
What a worst-case scenario means: I do not expect that an all-out trade war with China would throw the US into a recession. However, my forecast for the 2019 GDP growth rate would drop from 3.3% to 2.75%…and for S&P 500 earnings growth, from 11% to 7%. Much weaker corporate performance coupled with higher interest rates could bring on a bear market in stocks sooner than the current outlook, perhaps by late 2019.